Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up and control a huge amount of money. Leveraging, which is also known as trading on margin, means you can make a profit if markets move in your favor, though you can also lose more than your initial deposit should markets move against you. This is because any profits and losses are based on the full value of the trade, and not just the deposit amount.
Understanding how to trade foreign currencies requires detailed knowledge about the economies and political situations of individual countries, global macroeconomics and the impact of volatility on specific markets. But the truth is, it isn’t usually economics or global finance that trip up first-time forex traders. Instead, a basic lack of knowledge on how to use leverage is often at the root of trading losses.
Leverage can provide substantial opportunity for forex traders, but it can also present them with a significant amount of risk. While an investor may be able to use borrowed funds to amplify returns greatly, harnessing leverage can also dramatically magnify losses. To harness leverage effectively, traders must not only learn its basics, but also develop a keen sense of its costs and benefits. Investors might feel quite enticed by the high returns they can generate by using leverage, but they should also keep in mind that using this approach can also create major losses.
Trading is a very much long game and this requires effective risk/money management and determining the right leverage for any given trading situation is an important part of this. Many veteran trading professionals will tell you that trading successfully over the long term requires mastering trading leverage. This means utilizing sufficient leverage to enable you to maximize your trading profitability but also minimizing trading leverage so that you never take “a big hit’ and that any one loss or series of losses does not compromise your trading capital and your participation “in the game”.
There is a relationship between leverage and its impact on your forex trading account. The greater the amount of effective leverage used, the greater the swings (up and down) in your account equity. The smaller the amount of leverage used, the smaller the swings (up or down) in your account equity. Using trailing stops, keeping positions small and limiting the amount of capital for each position is a good start to learning the proper way to manage leverage.